Capital Senior Living Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: Capital Senior (CSU)

Capital Senior Living (NYSE:CSU)

Q3 2013 Earnings Call

November 04, 2013 5:00 pm ET

Executives

Lawrence A. Cohen - Chief Executive Officer and Vice Chairman

Ralph A. Beattie - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Darren P. Lehrich - Deutsche Bank AG, Research Division

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Dana Hambly - Stephens Inc., Research Division

Todd Cohen

Operator

Good day, everyone, and welcome to the Capital Senior Living Third Quarter 2013 Earnings Release Conference Call. Today's conference is being recorded.

The forward-looking statements in this release are subject to certain risks and uncertainties that could cause results to differ materially, including, but not without limitation, to the company's ability to find suitable acquisition properties at favorable terms; financing; licensing; business conditions; risks of downturns and economic conditions generally; satisfaction of closing conditions, such as those pertaining to licensure; availability of insurance at commercially reasonable rates; and changes in accounting principles and interpretations among others; and other risks and factors identified from time to time in our reports filed with the Securities and Exchange Commission.

At this time, I would like to turn the call over to Mr. Larry Cohen. Please go ahead, sir.

Lawrence A. Cohen

Thank you very much. Good afternoon, and welcome to Capital Senior Living's Third Quarter 2013 Earnings Release Conference Call.

I'm very pleased to report positive results for the third quarter as we recovered from the effects of the flu season earlier this year. Same-community occupancies at the end of September improved 70 basis points from the end of June, and same-store average monthly rents increased 2.9% from the third quarter of the prior year. This significant increase, along with a 20% increase in third quarter deposits, bodes well for fourth quarter financial results.

I am also pleased to report that the repositioning of our 2 continuing care retirement communities to further enhance our private-pay revenues is proceeding well. After considering a number of alternatives, including a sale of these owned communities, we've decided that a reconfiguration of the services we offer will enhance annual CFFO, improve our operating metrics and enable meaningful gains in shareholder value. The residents we serve in skilled nursing will all have been relocated to other nursing homes by the end of this week, and we will soon begin reconfiguring this space for private-pay use. With the closing of these skilled nursing units, 97% of our revenues are derived from private-pay sources. Complementing our organic growth is a robust pipeline that allows us to continue our disciplined and strategic acquisition program that increases our ownership of high-quality senior living communities in geographically concentrated regions and generates meaningful increases in CFFO, earnings and real estate value.

We differentiate Capital Senior Living as the value leader in providing quality seniors housing and care at reasonable prices. We are well positioned to make meaningful gains in shareholder value as a substantially private-pay business in an industry that benefits from need-driven demand, limited new supply and an improving economy and housing market.

In the third quarter, we completed the acquisition of 2 senior living communities in Ohio and Georgia for a combined purchase price of approximately $21.6 million. These communities were financed with an aggregate of approximately $16.1 million of non-recourse mortgage debt consisting of $7.6 million of 10-year debt with a fixed interest rate of 5.93% and bridge financing of approximately $8.5 million with a variable interest rate of approximately 3.9%. The bridge loan is for a community that we are upgrading its assisted living license, and after completion, will be refinanced with permanent financing.

Subsequent to the end of the third quarter, we completed the acquisition of 2 senior living communities in Wisconsin and Massachusetts for a combined purchase price of approximately $31.8 million. The 2 communities were financed with an aggregate of approximately $23.8 million of non-recourse 10-year mortgage debt with a blended fixed interest rate of 5.44%. We are pleased to add the contiguous states of Georgia, Massachusetts and Wisconsin to our operating footprint as we enhance our geographically concentrated operating centers. These $53.4 million of combined acquisitions are expected to add CFFO of $0.08 per share, increase earnings by $0.04 per share, increase revenue by $12.8 million and generate an effective cash-on-cash return on equity of 17%.

We are conducting due diligence on approximately $65 million of additional transactions of high-quality senior living communities in regions with extensive operations. Subject to completion of due diligence and customary closing conditions, these transactions are expected to close in the fourth quarter of this year.

Our pipeline remains robust, and we are conducting due diligence on additional transactions consisting of high-quality senior living communities in regions where we have extensive operations that are expected to close in 2014.

I am pleased to report that, in addition to the success we are experiencing with our acquisition program, we are also achieving strong operating results with gains in occupancy and net operating income. We benefit from a talented team of senior living professionals whose focus and discipline, combined with our proprietary expense management systems, our community-based empowerment philosophy, our operating strategy to provide value and quality services and care to our senior living residents can generate solid operating results. We believe we are different from other companies in our peer group with our sole focus on the substantially all private-pay senior living business as we are able to capitalize on our competitive strengths in operating communities in geographically concentrated regions and profit from our competitive advantages as a larger company with economies of scale and proprietary systems operating in a highly fragmented industry that continue to generate excellent results.

We have enhanced our private-pay revenues by closing the only skilled nursing beds we have operated and are repositioning our 2 CCRCs to other private-pay use. While these 2 communities are being repositioned, they will be excluded from same-community results.

At communities under management, same-community revenue in the third quarter of 2013 increased 2.4% versus the third quarter 2012. Same-community expenses increased 1.3%, and net operating income increased 3.9%.

Third quarter average financial occupancy was dampened by the cumulative effect of the flu season in the first half of the year. I am pleased to report that during the quarter, occupancies rebounded with assisted living occupancies increasing by 80 basis points and independent living occupancies increasing by 40 basis points from the end of June to the end of September. Same-store occupancies were 70 basis points higher at the end of September than at the end of June and deposit-taking during the quarter improved 20% from the second quarter. These significant improvements in operations bodes well for fourth quarter financial results.

Third quarter 2013 same-community average monthly rents were 2.9% higher than third quarter of 2012 with independent living rents improving 2.4% and assisted living rents improving 3% from the third quarter of 2012. Sequentially, third quarter same-community average monthly rents increased 90 basis points. Our 70 basis points growth in same-store occupancy and same-store average monthly rent growth of 2.9% compared favorably to NIC MAP data, which reported sequential third quarter occupancy growth of 50 basis points and rate growth of 1% for independent living and 2.3% for assisted living in the top 100 MSAs.

Industry fundamentals continue to be strong with demand outpacing supply. NIC MAP reported favorable supply-demand trends for independent and assisted living communities with lower trailing 12-month construction starts as a percent of supply and improved unit absorption to supply for the third quarter of 2013.

As we have discussed on previous calls, we have been able to review with the NIC MAP staff construction starts in Dallas and Houston and compare them to our existing communities. Once again, I am pleased to report that none of the construction activity currently underway in these 2 cities is competitive with any of our Texas communities. This confirms that our value strategy with average monthly rents of $3,043 acts as an economic barrier to entry for new development with replacement costs averaging in excess of $175,000 per unit. Rents would have to be about 50% higher than current levels to generate a reasonable return on the cost of development, indicating the opportunity to realize significant rent growth before we expect to see new construction in most of our markets.

With strong industry fundamentals, an improving economy and housing market and virtually no new supply in our markets, we believe that our occupancies can continue to grow to an optimal level of 92% to 93%, leading tremendous opportunity for additional organically driven CFFO growth and increases in our real estate values.

Our positive results demonstrate that our team, with its disciplined focus and attention to detail, is successfully executing our operating strategy. Successful senior living operations require well-located communities with the right on-site team supported by strong regional and corporate resources. We are fortunate to continue to recruit and retain many of the best operations and sales and marketing professionals in the senior living industry.

I'd like to take a moment to talk about Capital Senior Living and our objectives going forward. Our mission is to provide quality senior living services and care to our residents at reasonable prices. Our competitive advantage that allows us to achieve solid operating results and disciplined growth is our people and our culture. We continue to execute on a strategic plan that is focused on our very important objective of enhancing shareholder value through organic growth, proactive expense management, accretive acquisitions, unit conversions and utilization of technology. With our on-site regional and corporate teams focus and discipline, we maintain our communities and train our staff to the highest standards in the industry, maximizing resident satisfaction, improving occupancy and increasing average monthly rents, operating margins and net operating income.

We continue to grow through a disciplined and strategic acquisition program that began in 2011 and that has been funded from internally generated cash flow. We completed $84 million of acquisitions in the second half of 2011, $180 million of acquisitions in 2012, and with transactions expected to be completed in the fourth quarter, we will have completed acquisitions totaling more than $150 million in 2013. As our cash flow continues to grow and a robust pipeline continues to provide us with ample quality acquisition opportunities, we expect to continue our successful acquisition program in future years.

While we will continue to maintain internal targets for annual acquisitions, we prefer not to provide public guidance since we expect to continue our disciplined approach to acquiring high-quality senior living communities in our geographically-concentrated regions and prefer not to be measured quarter-to-quarter by acquisition targets.

We have a proven track record of completing successful acquisitions. Since the middle of 2011, we have purchased 31 communities for a combined price of $350 million. These strategic acquisitions generate CFFO of $0.60 per share in the first year of operations and greater than a 17% initial cash on -- cash return on invested equity. And we expect to add an additional $65 million of acquisitions in the fourth quarter of this year.

Our success in acquiring quality communities in off-market transactions confirms our competitive advantage as a highly respected and credible owner-operator with a financial capability to complete transactions. Many local and regional operators continue to tell us that they prefer to transact transactions with Capital Senior Living as opposed to REITs or private equity investors as they feel comfortable in trusting their residents and staff to the Capital Senior Living family, and many don't feel comfortable with taking on long-term recourse lease obligations with thin coverage ratios. This is evidenced by the fact that 50% of the communities we have or will purchase in 2013 are with sellers that we have completed previous transactions.

To put some perspective around our acquisition program, I would like to review our year-to-date acquisition activity through October. We have evaluated 49 transactions, of which -- of 70% were marketed by brokers and 30% were between principles with no formal marketing process. Of the 70% marketed deals, we made offers on 30% of which 20% were accepted. Of the 30% off-market transactions, we submitted offers on 75%, of which is 75% were accepted. In the first 10 months of the year, we submitted offers on nearly $700 million of acquisition targets located within our geographically concentrated regions and have gone to contract on nearly $180 million of transactions. We terminated $30 million of acquisitions during due diligence and expect to complete more than $150 million of acquisitions this year.

Our robust pipeline and strong off-market relationships provide excellent visibility for acquisitions during the first half of 2014, many of which will be with sellers we have previously completed transactions.

We are excited about our growth as seniors housing is a need-driven product with a very limited new supply. Demographic demand growth is driven by an aging population. These favorable demographic and supply-demand trends should allow for continued occupancy and rate growth.

We are also benefiting from our investments in cash flow-enhancing renovations, refurbishments and conversions of units to higher levels of care. These initiatives, combined with the operating leverage in our prudently financed business, are expected to increase revenues, margins and cash flow. Each 3% increase in average monthly rent generates approximately $10.4 million of incremental revenue. Every 1% improvement in occupancy is expected to generate $3.5 million of revenue, $2.5 million of EBITDAR and $0.06 per share of CFFO. We have had much success in converting units to higher levels of care to meet the needs of our residents and allow them to age in place, as well as generate excellent financial returns to our company and our shareholders.

In 2013, we received approvals to convert 210 units of independent living to assisted living. When stabilized, these new conversions are expected to add approximately $3.4 million of incremental revenue and $2 million of EBITDAR. We are also pursuing conversion opportunities for 2014, which, upon approval, would increase levels of care at approximately 360 units with the potential to further increase revenue by nearly $6 million and EBITDAR by $3.6 million. We are also evaluating expansions on existing communities that are very well occupied that would increase capacity by a combined 120 units.

As we execute our strategic business plan, we are enhancing our geographic concentration with expanded care to residents, maximizing our competitive strengths and lowering our cost of capital. Our strategy is focused on generating attractive returns, enhancing free cash flow and maximizing shareholder value.

Successful execution of our business plan has resulted in EBITDAR growth of 105% on an 84% increase of revenues in just over 3 years. Our EBITDAR margin has increased by more than 500 basis points. We are able to leverage our geographically concentrated operating platform and benefit from economies of scale; our group purchasing program; proprietary, proactive expense management systems; risk management and insurance programs; as well as a focused marketing plans to integrate acquisitions in a highly accretive manner. Our success in acquiring high-quality senior living communities on attractive terms validates Capital Senior Living's competitive advantage as an owner-operator with a geographic focus, able to successfully assimilate acquisitions with minimal incremental costs. And our liquidity and balance sheet are solid, allowing us to have the capacity to comfortably fund our working capital, maintain our communities, retain prudent reserves and have the equity to fund future acquisitions. We are well positioned to add to our success, and I am optimistic that our future as I am confident in our team's ability to continue our successful execution of a well-conceived and simple strategic plan.

We expect continued significant growth in CFFO, earnings and owned real estate that will lead to a meaningful increase in shareholder value. Our fundamentals are strong, and I am excited about the company's prospects as we benefit from our substantially all private-pay strategy in an industry that is benefiting from need-driven demand limited new supply and improving economy, as well as a housing market.

I would now like to introduce Ralph Beattie, our Chief Financial Officer, to review the company's financial results for the third quarter of 2013. Ralph?

Ralph A. Beattie

Thanks, Larry. Good afternoon. I hope everyone has had a chance to see the press release, which was distributed earlier today. In the next few minutes, I'm going to review and expand upon highlights of our financial results for the third quarter and first 9 months of 2013. A copy of the press release is available on our corporate website at www.capitalsenior.com. And if you would like to receive future press releases by email, there's a place on our website for you to provide your email address.

For the third quarter of 2013, the company reported revenue of $88 million compared to revenue of $78 million for the third quarter of 2012, an increase of $10 million or 12.8%. Resident and health care revenue increased from the third quarter of the prior year by $9.8 million or 12.7%. We consolidated 103 communities on our income statement this quarter versus 88 in the third quarter of the prior year.

Financial occupancy at the consolidated portfolio averaged 86.4% in the third quarter of 2013, excluding 2 continuing care retirement communities that are being repositioned. Average monthly rent was $3,023 per occupied unit in the third quarter of 2013, an increase of $111 per occupied unit, 3.8% higher than the third quarter of 2012. On a same-community basis, excluding the 2 CCRCs being repositioned, same-community average rents were 2.9% higher than the third quarter of 2012.

On a same-community basis, revenues increased 2.4% versus the third quarter of 2012, expenses increased 1.3% and net income grew 3.9%.

As a percentage of resident and health care revenue, operating expenses were 61.3% in the third quarter of 2013.

General and administrative expenses as a percentage of revenues under management were 5.5% in the third quarter of 2013, excluding transaction costs of approximately $0.4 million in the quarter. General and administrative expenses in 2013 have been impacted by an abnormally high level of medical claims. The company is self-insured for the cost of employee and dependent medical benefits and purchased a stop-loss protection. Without a doubt, this self-insurance program significantly reduces the company's health insurance costs.

In some periods, expenses are higher than average due to the number of claims processed and the average cost per claim. In 8 of the last 10 years, the medical claims have been remarkably consistent and predictable. 2008 and 2013 are exceptions. Our cost per employee has increased at an average rate of 4.2% per year over the last 8 years compared to a national average of 7.1% so the plan has been very beneficial to the company. So far this year, there have been about twice the number of major claims that there were in 2012. This relatively small number of major claims accounts for most of the increased costs.

Health care costs in the third quarter of 2013 exceeded the third quarter of 2012 by approximately $1.2 million, reducing earnings and cash flow by approximately $0.03 per share. Our experience of medical claims is that they tend to even out over time, and we believe that our self-insured plan has saved the company over $5 million in the last 9 years.

Adjusted EBITDAR for the third quarter of 2013 was approximately $29.3 million and adjusted EBITDAR margin was 35.2% for the period, excluding the 2 CCRCs being repositioned. Since the first quarter of 2010, revenues have increased 84%, EBITDAR has increased 105% and EBITDAR margin has grown by 530 basis points.

Adjusted net income for the third quarter of 2013 was $0.4 million or $0.03 per share, excluding the nonrecurring and noneconomic items reconciled in the press release.

Adjusted CFFO was $8.9 million or $0.32 per share in the third quarter of 2013.

As Larry said earlier, we are in the third year of our highly successful acquisition program. The acquisitions we have completed have significantly improved CFFO and substantially increased shareholder value. GAAP requires us to allocate a significant portion of the purchase price for each acquisition to the value of residents in place. These resident leases are then amortized or written off over a 12-month period, representing an estimate of the remaining time that an average resident will remain in the building. This large noneconomic and non-cash expense has led us to anticipate a 3-year cumulative loss for GAAP, and consequently, we have booked an allowance against the deferred tax asset we have been accumulating.

Moving to the 9-month results. The company reported revenue of $261.4 million, an increase of 15% from the first 9 months of 2012. Adjusted EBITDAR was $89.8 million for the first 9 months of 2013, excluding the 2 communities being repositioned. EBITDAR increased $9 million from the first 9 months of the prior year and EBITDAR margin was 35%. Adjusted net income was $3.6 million or $0.13 per share in the first 9 months of 2013. And CFFO was $28.1 million, or $1.01 per share, an increase of $4.2 million or $0.14 per share from the first 9 months of 2012. CFFO increased 17.6% versus the first 9 months of the prior year.

The company ended the third quarter of 2013 with $30.2 million of cash and cash equivalents, including restricted cash.

Since the end of the quarter, we have received approximately $1.4 million from the sale of the nursing beds in one of our CCRCs, and we anticipate selling the nursing beds from the other one this quarter. We have also received approximately $3.5 million from one of our lessors as a return of escrow deposits.

As of September 30, 2013, the company financed its 53 owned communities with mortgages totaling $395.6 million at interest rates averaging 5.21%.

All of the company's debt is at fixed interest rates, except 2 bridge loans, totaling $13 million at variable rates. The company has no mortgage maturities before the third quarter of 2015.

Our coverages remain very strong. Our interest coverage is 2.7x and our total fixed charge coverage is 1.5x.

Capital expenditures for the quarter were approximately $4.7 million, representing $3.7 million of investment spending and $1 million of recurring CapEx. If annualized, the company spent approximately $400 per unit on recurring CapEx in the quarter.

We'd now like to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Darren Lehrich with Deutsche Bank.

Darren P. Lehrich - Deutsche Bank AG, Research Division

I guess, I just wanted to start out with a question around the commentary you're providing on acquisitions. Certainly, can appreciate the success you've had over the last several years. I just want to make sure we're interpreting the commentary correctly. Are you seeing anything change in the acquisition environment that makes you any less confident about your ability to pace yourselves at a similar level? And maybe if you can just frame that. I guess, the context certainly is that, I think, originally, you provided some framework for thinking about acquisitions and that somehow morphed into a target or guidance and I'm just wondering if you're just trying to correct that.

Lawrence A. Cohen

Darren, thank you. Exactly. I will take full blame responding earlier in the year to questions about the plans -- we do have internal goals, we never plan to give guidance. We are very confident. I cannot stress how confident we are on the acquisitions moving forward. Pipeline is -- I got to tell you, pipeline keeps getting better. It's remarkable. We're seeing hundreds of millions of dollars of acquisitions monthly. We are seeing, as I mentioned, the repeat business with sellers that we dealt with previously. We have excellent visibility for the first half of 2014. All we are trying to do is correct what was interpreted to be guidance so that -- and quite frankly, as our cash flow is growing, we hope to increase the number of acquisitions we can make because we're generating more cash flow that we can fund the acquisitions with. So it was only to try to remedy the fact that people read into some of my comments that there was guidance for the year. But we are highly confident, I appreciate the question. I ask everyone not to read into it at all. The program continues to be very successful, and we're very excited about our future as we look at additional acquisitions.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Got it, okay. I guess, just as it relates to the same-store occupancy trends, intra-quarter you're framing for us a much stronger end. I guess, I'd be curious just to maybe look inside the quarter and see how your operators experienced occupancy, whether it was dips in certain geographies, whether there was something that you might be able to put a little more insight into on the overall trend on a same-store basis.

Lawrence A. Cohen

I'd be happy to. It's interesting. As I commented on the second quarter, we ended very strong in June. I mean, obviously, we had the effects of the flu that impacted the first half. We had a very good end to June. July, we had higher attrition, which just kind of happened. So we had a net loss in July. There was nothing geographically about it at all. Actually, what we saw in July was the -- what's interesting about the quarter, starting with the first week of July, we started to see a consistency in deposit-taking that's the highest I've ever seen in our company's history. And I commented, we started to see deposits, weekly deposits, increasing 20% greater than we saw in the second quarter, which clearly were above the first quarter with the effects of the flu. And we had a run starting around the second week of August through September both on move-ins, lower attrition, higher deposits that were very encouraging. So if you do the kind of the math, we had a loss in July. August and September had an equal number of net move-ins, which is very encouraging. And for the quarter, we ended up with 74 more residents on a same-store basis at the end of September than we had in June, which results in a 70 basis point improvement in occupancy. And the anomaly is the average financial occupancy was, as I said, was dampened because of just the fact that you've got this cumulative effect. We're hopeful that, in the fourth quarter, we'll start to get the benefit of the success that we had at the second half, really of the third quarter, to start seeing better financial occupancy and gains in the fourth quarter.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Got it. And just one last thing before I jump off here. So you're expressing confidence around Q4. But did you see any attrition, thus far, in the quarter? So you've got good visibility in deposits. But what about the attrition side of the equation?

Lawrence A. Cohen

Attrition in the fourth quarter. Right now, I mean, we're only talking about 4 weeks. We're working now at levels, which are actually below first and second and pretty -- it's actually a little less than -- pretty similar to third quarter. So we're hopeful that we'll start to see positive trends. Right now, the trends for the quarter, additionally, are positive. Incremental to what we had in the third quarter.

Operator

[Operator Instructions] Next we'll go to Daniel Bernstein with Stifel, Nicolaus.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

I just want to make sure. What did you say would be the average financial occupancy change quarter-over-quarter rather than the quarter end?

Ralph A. Beattie

Well, what Larry's referring to, Dan, was actually the physical occupancy, not the financial occupancy.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Right. Okay, okay. Do you have an average for the quarter rather than -- I was just trying to understand, the 70 bps was a quarter-end-to-quarter-end. What was the change on an average basis Q-over-Q?

Lawrence A. Cohen

Well, again, when you say on average, it was -- it's 70 bps. That is the average. If I'm saying, if you take a July, August and September and take the average, actually the average -- I think, the average would have been about 24 basis points. This is the average exactly. The average would have been a positive 24 basis points. You take 74 divided by 3 we had gained.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay, okay. And then, does that include -- that same-store, is that equal to the same-store, 89 properties, you have in the supplemental? Or is that 102 properties just excluding the 2 CCRCs?

Lawrence A. Cohen

It's taking -- it's 100 properties Q2 to Q3 of this year.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. I just want to make sure whether it was apples-to-apples or apples-to-oranges with year-over-year data...

Lawrence A. Cohen

It was apples-to-apples. We did not include any acquisitions in it.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay, okay, okay. And then on the year -- the year-over-year numbers, it looked like again, on the same-store, the 89 properties occupancy went down a little bit. I just -- again, it doesn't include a large number of properties that you have. But I just want to understand what might -- what was influencing that number? And then, maybe I have one more question after that.

Lawrence A. Cohen

Again, the year-over-year, unfortunately, is the cumulative effect of the flu season and the residual flu season for the first half of the year. So when you look at the numbers, you're starting, in the whole, if you will, on a comparable basis and that's why you see the drop year-over-year. We think the sequential -- both for purposes of what NIC MAP does -- by the way, our methodology using the 70 basis points end-to-end is identical to NIC MAP methodology. So we want to be consistent. We're showing trend lines and being consistent with how the industry reports. But the average, unfortunately, was dampened by the effect of the flu and carrying over into the second quarter.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And by the way, I would just note that even though you're not giving guidance or what you had before wasn't guidance, you're actually making your non-guidance, so...

Lawrence A. Cohen

Well, thank you, [indiscernible] and by the way, we also [indiscernible] guidance, too, okay?

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

One question here on the pipeline. I don't know if you could characterize if the pipeline is similar to what you're doing before in terms of assisted living versus independent living? And if you've seen any movement in cap rates given the amount of cash money that's kind of flowing into the industry from non-traded REITs and private equity. And I guess, in a related question here, given the amount of construction that I think maybe has picked up in assisted living, are you looking maybe -- would you consider maybe looking at more independent living assets versus AL? Just trying to get a total picture of how you're thinking about the pipeline and where that's heading?

Lawrence A. Cohen

Sure. Right now, we have a good combination of independent living and assisted living and memory care. What we have been seeing in the marketplace has been more either 3 levels of care or assisted living or assisted living with memory care. It's more a function of construction cycles. There really has been very little independent living built nationwide since around 2000. So when you look at that most of the buildings that we are building are newer than 10 years, they are typically going to be more heavily weighted to AL and memory care. As I -- you saw this quarter and last quarter, we made 2 acquisitions. We're actually enhancing the licensing on those buildings from what the prior operator was serving and we think that will significantly increase the cash flow. In the second quarter, we acquired a building about 45 units. We're now licensing that building. We think the cash flow in that building will actually increase by about 50% within almost 3 years as we start to see the effect of the higher license. So we're very comfortable with the mix. We still -- by the way, our AL and memory care still is a very solid 90% week-to-week. So we had not seen any, any impact at all, as I said. We're not seeing construction. We're not hearing about construction. We're not seeing it in our numbers at all. So in the markets in which we're operating, we're not concerned about what's out there. We think a lot of what's being built is in more affluent markets that we're looking at, as well as freestanding memory care. As far as cap rates, as I think I said previously, because we do have both some people from the press as well as some people that we transact business with on the line, we prefer not to say our cap rates. I will say that we have seen, interestingly, over the last few months, in brokered transactions some newer investors to our sector, which were more traditionally multi-family investors that are actually bringing down cap rates, which is interesting. It's not the REITs; it's really more, more traditional multifamily investors that find a better spread and something that NIC has done an excellent job in. If you look at the data, and again, you on the other end has had such an excellent job of educating the investor community. The best-performing real estate of all asset classes during the recession and coming out of the recession is seniors housing. I was at a board meeting of NIC about a month ago, and the economist from the EW [ph] had a chart. The only real estate asset class that had increases in rent from 2008 to 2010 was seniors housing. So I think there's just a lot more confidence in the asset class. I think that it's proven itself to be extremely resilient and a very strong performer. So I think that's a good thing. Fortunately, we've been very consistent in our acquisitions. We have an excellent relationship with a lot of smaller regional operators that like transacting with us that never get to market. Most of the transactions we're looking at for 2014 at this point are off-market transactions. So we participate very often to get a good feel. And again, we still have a huge advantage. I believe we're the only owner-operator bidding on these properties. Everyone else is teaming up with an equity source of some sort. And the fact that we are able to assimilate these buildings in our regions with very minimal incremental cost gives us a tremendous advantage because we're able to get 150 basis point or so spread in yield versus someone who has to hire a manager that allows us to be highly competitive if we want to be on the brokered deals as well. So the interesting dynamic out there, I think, it bodes well for the industry. I think it bodes well for valuations of the public peers because the fact that the real estate values are probably higher than the market appreciates and we feel that we're very well positioned to continue, without guidance, our acquisition program.

Operator

And next, we'll hear from Dana Hambly with Stephens.

Dana Hambly - Stephens Inc., Research Division

Larry, could you just -- I was a little curious on July because when you reported the last quarter, it sounded like July and August were trending pretty well. And so I just wanted to get a little bit more color. Did it -- is July typically a big attrition month for you? Or is this just an abnormal one compared to REIT?

Lawrence A. Cohen

It was abnormal. Dana, it was abnormal. When we did the call, I don't have the numbers right in front of me, but we started to see a nice pickup in deposits starting with the week of July 6, right? It got better the week of July 20. And really, it was very strong. We just, unfortunately, had a -- we had -- with this amount of business, we had 1 extra week of attrition that we typically see that skewed our numbers. I mean, that's how granular you can be in this business, if you will. So by the third, fourth week of the month, we expect to start to see really strong net gains. And while we were very encouraged by deposit-taking, I mean, July 12, 102 deposits; 105 in July 19; 99 July 26. I mean, those are really strong numbers. Unfortunately, we had a week with 137 move-outs that we didn't anticipate. So it was really just 1 bad week that kind of hurt the whole month. But the trend -- and we saw it come to fruition in August and September, of course, those deposits moved in over the next 30 to 60 days.

Dana Hambly - Stephens Inc., Research Division

Okay, all right. That makes sense. And just, Ralph, obviously, the health care claims continue to frustrate. Any other unusual items that are worth causing out -- calling out in the expenses?

Ralph A. Beattie

Really, Dana, that's about it. The rest of it was very much in line. We did increase our operating infrastructure in the third quarter, which will lead to a higher rate of G&A going forward. But we expect that to be more than offset by improved operating performance through the promotions that we've had in the organization. So there is a little additional manpower in place. But we expect that to more than be paid for by the improvement in operations.

Dana Hambly - Stephens Inc., Research Division

Okay, okay. And just the last one for me, just on rates to finance these deals. Your second quarter rate were like 5.93%. The stuff that you just closed in the third quarter was 5.44%. What should we think about going forward? Or what are you seeing in rates right now? Have we inched down from there?

Ralph A. Beattie

Well, what happened to us, Dana, was we closed 2 communities in September whenever the 10-year had spiked and we closed those at 5.93%. Then we closed 2 more in October and our fixed rate on one of those was 5.44%. So it's actually backed off about 50 basis points from the peak. Our borrowing rate today is probably in the mid-5s. And we think that, that's very attractive based upon the fact that it's 10-year fixed rate nonrecourse debt with 30-year amortization. So I'd say today, our borrowing rate's about 5.5% and we're very pleased to be able to borrow at that rate.

Lawrence A. Cohen

I would say 5.25% to 5.5% is kind of the range. Right now, it's [indiscernible] 260 [ph]. Based on the spread, it'd probably be 5.25% to 5.5%.

Dana Hambly - Stephens Inc., Research Division

If we're still getting kind of mid- to high cash-on-cash returns then?

Lawrence A. Cohen

We're still getting 17%. That's what's interesting. Look at our numbers. Look at the numbers in the release, the CFFO on equity, even with the rates being higher, we're still 17%. We are still being able to capture that spread in cap rate to interest rate that's allowing us 17% or so return on equity, which is also higher than what our expectation has been in this acquisition program, but they're very consistent with what we've done over the last 2.5 years.

Dana Hambly - Stephens Inc., Research Division

Okay. I'm sorry, just relative to -- when you started the acquisition program, what were you thinking more kind of the cash-on-cash returns?

Ralph A. Beattie

12% to 13%

Lawrence A. Cohen

At that time, the interest rates were actually 6.5%. When we presented the strategy to the board at the end of 2010, we thought we'd be buying properties at effective cap rate at 8%, financing at 6.5% and the kind of cash-on-cash return will be 12% to 13%. We ended up buying things better than we expected, and interest rates have continued to be lower than we expected.

Operator

And next from MTC Advisors, we'll hear from Todd Cohen.

Todd Cohen

So just a couple questions and 1 to -- I think you may have hit on this just recently, but I missed a part of it. Some of these acquisitions that you are making you're doing this bridge financing and apparently that's so that you can get -- you can convert some of these units to different types of care. And I don't know if I heard you say this, but is the expense associated -- even though you have an expense associated with doing that, will your cash-on-cash returns be somewhat higher than what the stated returns look like on the metrics you've provided when those conversions get done?

Lawrence A. Cohen

Actually, Todd, what's interesting in the acquisitions, we have virtually no expense. I mean, these are, as of write, in the stage where they operate that they can be converted to higher levels of care within the building code, conformity of these buildings. It was just the fact that the sellers didn't have the highest level of licensure for these buildings. So that they're very -- virtually no cost for the conversion. The returns, as I said, if you think about it, in one case, the average monthly rents will be -- could be as much as $1,000 higher than they are today. And when you spread that across a building, you could see on -- once those are stabilized that the actual cash returns could be 50% higher. I'm all about one out where on conversion, we could be buying things at an unlevered 14% return on purchase price and if you lever -- put the debt on, it's very, very high. So now...

Todd Cohen

Well, you do have debt on them, so it is high, right? I mean, these are all levered?

Lawrence A. Cohen

Yes. And if you think about it, if you're buying a property at an unlevered return at 14% and putting on 70% leverage at, say, 5.5%, you're going to get a very high return on that.

Todd Cohen

Okay. And then kind of going back to this question of guidance and non-guidance on acquisitions, I think the important thing is that -- is your financial capability. And so in my mind, I'm thinking that based on the pace at which you've done acquisitions this year and if, in fact, you get to your goal with another $65 million in the back -- in the fourth quarter, that we go into 2014 with a substantial increase in returns going forward. So I would think that would give you better financial capability to do at least the amount of deals you've done almost on an annualized basis going back the last 2.5 years. Is that -- does that make sense?

Lawrence A. Cohen

That's very well articulated. We agree with that. Thank you.

Operator

[Operator Instructions] And it appears there are no further questions. I would like to turn the conference back over to Mr. Cohen for any additional or concluding remarks.

Lawrence A. Cohen

Well, we thank you all for participating this afternoon. And of course, feel free to give Ralph or myself any follow-up calls, and we look forward to seeing you at a variety of conferences over the next couple of months. Thank you very much, and enjoy your evening.

Operator

Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation.

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